When you form an LLC (limited liability company), paying yourself is a little more complicated than it is when you run a sole proprietorship. Unlike other corporate structures, an LLC is easy to start, protects your personal assets in case of a lawsuit, but can be quite complex in terms of finance and set up.
Howbeit, it is always advisable to seek the expertise of an attorney or CPA before forming any type of business. Although LLCs are fairly simple compared to corporations, an attorney or CPA can guide you through the process to determine which structure suits your business best.
Meanwhile, one of the major reasons small business owners structure their businesses as an LLC is because it is a pass-through tax entity for federal income tax purposes. This simply means that the LLC’s gains, losses, income, deductions, credits, and other tax items flow through to the member(s). The LLC is not subject to an entity-level tax unless it chooses to be taxed like a C corporation.
However, the LLC’s pass-through entity status does not entail that there are no tax considerations involved in operating a company as an LLC. While there may not be entity-level income tax liability at the federal level (unless you choose to be taxed like a C corporation), a multi-member LLC must still file an information report. In addition, the LLC may be liable for other types of taxes and may be required to file various returns with state and local governments.
Also, an LLC is a shape shifter—it can file taxes as many different types of business entities. Depending on which structure you elect at tax time, the IRS will treat it as a sole proprietorship, partnership, or corporation. If you are the only member of your LLC, it is a single-member company, and it will be taxed as a sole proprietorship.
However, if your LLC has multiple members, you can elect to be taxed either as a partnership or a corporation. Even though they’re both multi-member entities, corporations and partnerships are taxed differently. That means members get paid differently, too. And since all businesses are different, be sure to check with your attorney or CPA to see if an LLC is a good choice for your business.
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How to Pay Yourself from a Single Member LLC
Have it in mind that you pay yourself from your single member LLC by making an owner’s draw. Your single-member LLC is considered a “disregarded entity.” Therefore, your company’s profits and your own income are one and the same.
At the end of the year, you report them with Schedule C of your personal tax return (IRS Form 1040). Note that making an owner’s draw is like officially acknowledging the fact that some of your LLC’s income is staying in the company as retained earnings, and some of it you are taking for personal use.
To make an owners draw, you just have to write yourself a check from your business account for the amount you are taking out of your business. You will deposit this check in your personal bank account. Then, you will have to record the withdrawal on the books as an owner’s draw—a reduction in your owner’s equity account and a Credit from your owner’s equity or capital account.
Note that the IRS charges income tax, minus any deductions, on your company’s earnings for the year. Your income doesn’t get taxed a second time.
If your business earned $50,000 last year, you will pay income tax on $50,000. If you take an owner’s draw of $10,000, you don’t need to pay income tax on that $10,000—it is already been taxed. You will, however, be expected to pay self-employment taxes on your draw.
Similar to the FICA taxes that get withheld from an employee’s pay check, self-employment taxes consist of money paid for Social Security and Medicare. The self-employment tax rate is 15.3%.So, when you draw that $10,000; you should set aside 15.3% ($1,530) to cover self-employment tax.
How to Pay Yourself from a Multi Member LLC
Note that how members of a multi-member LLC get paid depends on whether it is a partnership, or a corporation. By default, the IRS treats every multi-member LLC as a partnership.
Paying yourself with a partnership LLC
Partners in an LLC are also allowed to take their earnings as draws, much like a single-member LLC. However, the partnership is a “pass-through” entity. This simple means that while it reports its income to the IRS with IRS Form 1065, the partnership isn’t taxed.
Instead, each member pays a portion of the total income tax on the partnership’s earnings. The size of that share is determined by the partnership agreement. At the end of every business year, each member receives an IRS Schedule K-1 from the partnership, reporting their share of the partnership’s income.
Schedule K-1 is used to prepare the partners’ personal income tax return. Notably, they pay full income tax on their share, even if they don’t draw all of it. So if your share in a partnership is 25%, but you only take half of that as a draw, you still pay income tax on 25% of the partnership’s earnings.
The money you draw as a partner isn’t charged income tax again. However, you will need to pay self-employment taxes—15.3%—on it. To protect your income as your LLC is progressing and becoming profitable, you can set up guaranteed payments. This will ensure you are paid out a minimum amount to partners regardless of profit.
Paying yourself from a corporate LLC
Shareholders (LLC members) in either an S corporation or a C corporation are not allowed to be paid in draws. Instead, they are expected to be hired as employees, and paid a salary. After that salary, they are allowed also to take an extra percentage of the corporation’s income in the form of dividends.
How much they take in dividends is laid out in the articles of incorporation. As an employee of your corporation, your income tax and payroll tax are automatically withheld from your earnings. Also remember that C corporations are double taxed. Meaning, the IRS charges your corporation income tax.
Then, everyone who earns wages or dividends from the corporation pays personal income tax on their earnings. One advantage of dividends: They’re exempt from payroll tax. So, the more of your income you receive as dividends, the less tax you need to pay. That being said, the IRS expects you to pay yourself “reasonable compensation.”
How Much to Pay Yourself from your LLC
When you earn a share of your LLC’s profits as salary, you have to make sure you are paying yourself well. If you are earning a $2,000 salary from your LLC that files a corporation and an additional $90,000 as dividends, you will attract the interest of the IRS, especially because you aren’t paying payroll tax on the $90,000.
Nonetheless, the best thing is to take all your personal expenses for the year and add them up. That is the minimum amount you need to earn.
It is also advisable you take a look at your bookkeeping with an accountant and analyze how much your business can afford to pay you, beyond the cost of covering personal expenses. Take your time to review earnings statistics according to industry and job position.
Find the average salary range for your job. However, remember that the less you earn as salary, and the more as dividends, the fewer taxes you will have to pay. The trick is striking the right balance. An accountant can help with this.
When your LLC pays a small business owner a salary, they are on the payroll; getting money from the company is fairly straightforward. However, the best way to move money from your business to your personal account is to leave a paper trail. When you make a draw, there must be records from a financial institution reporting how much you took.
If there is no official record of the draw, the lines fade between your personal income and business finances. In terms of legal action or a lien, the tax court may decide the liability protection of your LLC doesn’t apply—so your personal assets are on the line. Other than that, it is normal as a business owner to take as many draws as you like, whenever you like. So long as you leave a solid paper trail, you are good to go.